By John Auers and John Mayes
While the past 18 months have been very difficult for most of the petroleum industry, there is one sector that has done quite well – the refiners. Low prices have stimulated demand, leading to strong growth in the consumption of most refined products. Refiners have had to run at very high utilizations just to keep up with this demand and this in turn has resulted in excellent refining margins and financial performance for refiners, not only in the U.S. but throughout the world. In this kind of environment you would expect that the downstream segment would be gearing up to expand capacity, but this does not appear to be the case, at least not yet. As a regular component of our Crude and Refined Products Outlook, the 2016 edition of which is due to be issued next week, TM&C provides an extensive and detailed assessment of new global refining projects. An early peek at that analysis shows that construction activity is slowing down, rather than speeding up. Certainly some of this is wariness by refiners to commit to expansions in an environment which contains a significant amount of uncertainty. While they are making a lot of money, they are keeping their “powder dry”, as they wait to see how supply, demand and price trends develop. We will address all of these factors in our 2016 outlook, focusing specifically in today’s blog on the capital construction environment we foresee developing over the next few years in the refining sector.
In developing our forecast for refining projects, we incorporate data from a wide ranging set of sources, including commercial and governmental press releases, internet sites, news stories, SEC filings, and other publicly available information to compile a list of announced projects. These projects are not just new refineries but also include expansions to existing sites and incorporate crude processing capabilities as well as downstream processing units. Unit rates, costs and feedstock data are recorded and product yields are estimated. Our time horizon is generally for six years. Beyond that time, projects are often more of intentions rather than substance and their likelihood of actual development is not as certain.
Our initial list is comprehensive and includes all announced projects. Just because a project is announced does not mean it will actually be constructed. A second list is compiled to only include the projects we believe will be completed. This is accomplished by assessing a numeric rating for each based on numerous criteria. We evaluate the financial capabilities of the project developers, their past track record of bringing projects to fruition, local crude availability and product demand requirements and other factors in assessing each project score. We then monitor each project during its construction to adjust the scope and completion date as necessary.
We have recently completed our most recent refinery construction survey which will be published in the upcoming release of our 2016 Crude and Refined Products Outlook in February. This list includes 137 projects which will be completed between 2016 and 2021. For this period, we estimate that nearly 6.8 million BPD of additional global crude processing capacity will be added while less than 3.0 million BPD of new conversion unit capacity will be added. Conversion units are processes which crack large molecules (gas oil or residual fuels) into smaller molecules (generally naphthas and distillates) such as coking units, hydrocrackers or fluid catalytic cracking units. These values are compared with the results of previous surveys in going back to 2009.
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The level of refining capacity additions in our current survey indicates a downturn from previous years. In fact, our current survey shows the third lowest crude processing additions of the last eight years. Of particular note is that this comes at a time when global demand is being stimulated higher as a result of the very low crude oil prices. Also noteworthy is the low level of conversion unit additions. The 3.0 million BPD of additions represents the lowest level of investment by the global refining industry in recent history and is less than half the level of additions which were forecast in our 2009 edition of the Outlook.
There has been a significant amount of refinery capacity added over the last ten years; by our estimates over 11 million BPD, which is 2 million BPD greater than the amount of demand growth in that time frame. In just the last couple of years several major projects have come on line (see Table 1 below) and as a result, there is currently a surplus of refining capacity in the world.
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In the short term (next two years), it appears that the momentum of construction activity is maintained, as several fairly significant projects are due to be completed, as shown in Table 2 below. However, fewer new major projects are expected for the post-2017 period. This slowdown in additions, combined with strong demand growth, could lead to a significant tightening of world refining capacity towards the end of the decade and into the 2020’s. Given the long lead time for major refining investments (generally three or more years), it is difficult to quickly overcome refining shortages.
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Should the refining market tighten, an additional “relief valve” could come in the form of increased utilization rates. Refineries rarely operate at peak rates for very long and numerous operational issues arise which force reductions in throughputs. High refining margins, however, can be excellent inducements to maximizing utilization rates.
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In the U.S., refining utilization rates have been climbing for several years. Rates were relatively low in 2009 (82.9%) following the Great Recession, but have been high in recent years. In 2014 and 2015, utilization rates in the U.S. exceeded 90% of operating capacity. Operating rates were particularly high in PADDs II, III, and IV where margins were at their highest but lagged in PADDs I and V due to the inability to deliver substantive volumes of low priced shale crudes.
At these levels, it would be very difficult for utilization rates in the U.S. to increase much further. Rates are generally substantially lower in other regions, particularly in developing countries. It is in these regions that processing rates could see significant increases, particularly in an environment with strong refining margins.
This subject is evaluated in greater detail in our 2016 Crude and Refined Products Outlook, which will be issued next week. The causes of the apparent reduced level of investments will be discussed as well as a projection of our global petroleum supply and demand balance which compares refining growth to increases in product demand. Also included in the The Outlook is a detailed forecast of both crude and product prices, an assessment of regulatory and policy impacts, along with the analysis of other factors which we believe will be important in determining the directions of petroleum markets. Additional details about The Outlook are provided on our company website at turnermason.com.